On January 9, 2019, the European Banking Authority (EBA) and the European Securities and Markets Authority (ESMA) each published advice on crypto-assets to the European Commission (EC) and the European Union institutions respectively. They report on the applicability and suitability of current EU law to crypto-assets within their respective sphere of regulatory supervision.
Both authorities conclude that crypto-asset related activities are currently relatively limited and do not appear to give rise to implications for financial stability. Having said that, both the EBA and ESMA note that crypto-assets raise challenges for competent authorities and market participants, as there is lack of clarity as to how the regulatory framework applies to such instruments and they identify certain risks and issues which they recommend should be further analysed or taken action on.
Applicability of financial services law
The EBA notes that crypto-assets are not recognised in any of the EU Member States or by the European Central Bank (ECB) as fiat money, deposits or other repayable funds within the meaning of the Capital Requirements Regulation (Regulation (EU) No. 575/2013 – CRR). Additionally, the EBA concludes that there may be cases where, based on its specifics, a crypto-asset qualifies as electronic money and will therefore fall within the scope of 2nd Electronic Money Directive (Directive 2009/110/EC – EMD2). In this case, if a firm carries out a payment service within the meaning of the 2nd Payment Services Directive (Directive 2015/2366/EU – PSD2) with such crypto-assets, this will fall within the scope of PSD2.
The EBA notes that where regulated financial institutions carry out crypto-asset activities, the competent authorities hold a range of robust supervisory powers that can be applied effectively to mitigate risks (as such activities qualify as other business activities for which a regulated entity must have appropriate arrangements in place to mitigate the operational and reputational risks involved). However, when it comes to the existing prudential framework (including the relevant capital and liquidity requirements), the EBA notes that there is currently no specific Pillar 2 treatment for crypto-assets, which the competent authorities may be required to impose. There may also be a need to clarify the appropriate accounting treatment of crypto-assets, which may have an impact on the consequential prudential treatment under current EU law (e.g. CRR). In this respect, EBA notes that it is actively engaged in the work that the Basel Committee on Banking Supervision is currently taking forward to clarify the prudential treatment of banks' exposure to the holding of crypto-assets. In the meantime, competent authorities are advised to adopt a conservative prudential approach and EBA recommends that the European Commission take steps where possible to promote consistency in the accounting treatment of crypto-assets.
Similarly to the EBA, ESMA reports that some of the crypto-assets that ESMA identified for its assessment may qualify as transferable securities or other types of financial instruments within the meaning of the 2nd Markets in Financial Instruments Directive (Directive 2014/65/EU – MiFID 2). Where financial services regulation applies to crypto-assets because they qualify as MiFID financial instruments, ESMA has identified a number of gaps and issues in the existing regulatory framework. As a result, some risks may be left unaddressed, while at the same time certain existing requirements may not be (entirely) relevant. In its report, ESMA identifies various issues in respect of MIFID 2, the Prospectus Directive and the Market Abuse Regulation, but also other EU financial services legislation.
Conclusions and recommendations
Ultimately, the actual qualification of crypto-assets and related activities is the responsibility of the national competent authorities and also depends on the implementation of the relevant EU financial services legislation into national law. EBA and ESMA highlight the risks this may pose to a level playing field and explicitly warn against the proliferation in national approaches across the EU. The supervisory authorities limit their comments to crypto-assets, but this is obviously a much broader issue.
Where crypto assets do not fall within the scope of EU financial services regulation, the EBA and ESMA believe that this leaves consumers exposed to substantial risks and that all crypto assets and related activities should be subject to anti-money laundering legislation. They confirm the Financial Action Task Force's (FATF) call to take urgent action to address money laundering and terrorism financing risks relation to crypto-assets currently not within the scope of the Anti-Money Laundering Directives (such as crypto-to-crypto exchanges)
The EBA recommends that the European Commission carries out a cost/benefit analysis to assess whether EU level action is appropriate and feasible. The European Commission is considered best positioned to carry out this assessment, as crypto-asset activities give rise to a wide range of issues, also outside the financial sector, and thus require a cross-sectoral approach. It also recommends that the European Commission consider the latest FATF's recommendations, standards and guidance in its assessment.
ESMA recommends that EU policymakers consider the opportunity to set up a bespoke regime for those crypto-assets that do not qualify as MiFID financial instruments or electronic money. Such a regime should be tailored to the specific risks and issues posed by crypto-assets and related activities (including the underlying technology) and provide for requirements depending on the type of crypto-asset.
ESMA acknowledges that wider regulation may have trade-offs, such as risking legitimising crypto-assets, and may require further supervisory resources. Therefore, at this stage, it advises that focus is placed on warning buyers about the risks of crypto-assets that do not qualify under regulated financial services legislation, for example as MiFID financial instruments or electronic money.